WHAT IS THE RISK FOR THE ECB? In yesterday's Daily Currency Focus, we said that the 1.45 level was significant support in the EUR/USD.A break below that level would have opened the door for a move down to 1.42. Even though the EUR/USD did take out the support to hit an intraday low of 1.4385, what was more impressive was the currency pair's reversal. The close back near today's high reflects strength rather than weakness. Trading desks and hedge funds have plenty of cash on hand to pick each other's pockets. This is happened today in my opinion especially with financials which have become "trading" vehicles. After some days of decline it was time to squeeze whatever short sellers were bold enough to carry positions for more than a couple of days. I have been a big fan of Norway as an investment destination for several years now. The idea is very simple; anything good for oil is good for Norway. Also, tying in yesterday’s post, Norway is a commodity based economy with surpluses galore which gives a great chance of zigging when the S&P 500 zags. I have been underweight financial stocks for the last few years for two big reasons; first was their weight being 20% or larger of the S&P 500, which is more than normal, and because of the inverted yield curve that first occurred a couple of years ago. It has been a very volatile week for the US dollar, even though compared to the beginning of the week, the exchange rate for the EUR/USD and USD/JPY has remained virtually unchanged. Risk reverals in the EUR/USD have hit an extreme level. The 25 delta 3 month risk reversals are at the highest level since June 2007. Whenever risk reversals hits critical levels, it indicates that everyone who wants to be long euros are already long and as a result, sentiment has hit an extreme. On Monday morning in Australia the tape was alive with trading in two of Australia's powerhouse miners as Oxiana (OXR AU) and Zinifex (ZFX AU) agreed to a friendly merger creating one of the world's largest diversified mining companies. Together the companies will carry a value of close to $12 Billion serving the Zinc, Lead, Copper, Silver, and Gold markets. Travelers to Europe this summer, myself included, are going to experience sticker shock even more severe than what we felt last year.

There is no question that the US labor market is deteriorating. Non-farm payrolls fell by -84k last month, driving the unemployment rate to a 5 yeer high of 6.1 percent. However what made FX traders really sell the dollar was the jump in the unemployment rate and the revisions. The US government said that 9k more jobs were lost in August than previously expected and 38k more jobs was lost in June. Even though we did not get the -100k print that we had expected last month, the US economy did lose 100k jobs in June. Since the beginning of the year a total of 605k jobs have been cut. We expect at least another 2 or 3 months of negative job growth before the labor market hits a bottom.

Over the past 30 years, the US economy has gone through 3 recessions and in each of those 3 recessions, there was a string of job losses that lasted for a minimum of 11 months.

This has triggered a sharp sell-off in the US dollar, driving USD/JPY towards our target of 105. The biggest weakness in the US dollar should be against the Japanese Yen. Against the Euro and British pound, this could be a temporary correction. Oil continues to trend lower while the financial markets are trading off risk aversion. The dollar is still benefitting flight to safety.

Weaker economic data has not stopped the dollar from rallying in the past. On a purchasing parity basis, the US dollar is still undervalued against the Euro and British pound. With the markets waiting for the Federal Reserve to deliver their first rate hike in 2 years and the European Central Bank to cut interest rates for the first time in 5 years, the expectations for completely diametric monetary policy is exactly what could drive the EUR/USD to 1.40 over the next few months or even weeks.

 

www.kathylien.com

On Friday, we are expecting the number one most market moving release for the US dollar - August Non-farm payrolls. Based upon the leading indicators for NFP, there is a decent chance that job losses could have topped 100k last month. I wrote this special report for GFT. You can catch my daily report on GFT's Research Page